Thursday, February 5, 2015

Will Germany Push Greece Over The Edge?

The ECB made it clear yesterday that the suspension of Greek sovereign debt as eligible collateral was due to it having become impossible to assume a successful conclusion of the current Greek troika program review.

In order to get that certainty back, and allow Greek debt back on to the ECB collateral list, there either has to be a successful conclusion of the current review - the chances of which are approximately zero - or an agreement on a new program for Greece. A program is essentially a set of rules attached to a bailout.

In the press conference following his meeting with German finance minister Wolfgang Schaeuble this morning, Greek finance minister Yanis Varoufakis suggested that Greece should receive a bridging program until the end of May to allow the new Greek government time to finalize details of their program proposals. A short term bridging program would not be enough to make the ECB change its mind on collateral eligibility, but it would give time for politicians to come to an agreement on a longer term solution for Greece.

That bridging program would have to be agreed by all members of the euro area at the next Eurogroup meeting on February 16 in Brussels.

Ahead of that Eurogroup meeting Varoufakis has very few allies he can rely on amongst euro area finance ministers, with only French finance minister offering public support for any new program.If a bridging program can be agreed at the Eurogroup meeting, there will then be some months of difficult negotiation ahead for Greece and its lenders. With Varoufakis today saying that he did not even reach an agreement to disagree with Schaeuble, all parties still have a long way to go to reach the necessary common ground for a sustainable agreement.

Absent that agreement, Greek banks can continue to rely on ELA funding for the moment. (See an explainer here for how ELA works)

However, if there is a complete breakdown in negotiations, it is likely that the ECB will then take the view that the Greek banks will have become insolvent at that point, due to their holdings of Greek debt.

Were that to happen, Greece would find itself not enjoying the full benefits of euro membership.

Zero Hedge was also quick to pounce Wednesday after the ECB lifted the waiver stating Greek government bonds are no longer going to be accepted as collateral. OMG!! Is this the end of Greece and the world as we know it?!? This is the typical nonsense Zero Hedge puts out every five minutes because the people funding that blog are by and large made up of short-selling gold bugs that love spreading doom and gloom (even if they've been dead wrong since the 2008 crisis erupted).

My dear readers, please don't get caught up in this 'Grexit' hysteria, ignore most of the nonsense being written on Greece because at the end of the day, that's exactly what it is, complete and utter nonsense. I'll be the first to admit, nobody including yours truly really knows how this will end but in my opinion, it's increasingly looking like checkmate by not for Greece.

Here is what we know. German Finance Minister Wolfgang Schaeuble met his Greek counterpart, Yanis Varoufakis on Thursday and they “agreed to disagree” in their meeting. Varoufakis added: "we didn’t even agree to disagree from where I’m standing.’’ All this political posturing is hardly suprising given that German and Greek leaders are sticking to their guns when it comes to these key negotiations.

As far as the ECB, everyone should take the time to carefully read Frances Coppola's comment, What on earth is the ECB up to?, where she shows using his older tweets on Twitter that "Varoufakis predicted that the ECB would attempt to pull funding from the Greek banks" over six months ago. In other words, Varoufakis was well aware of these actions and probably even asked the ECB's Mario Draghi to go ahead and do it when they met earlier this week.

Here is where it gets interesting. Coppola ends her brilliant comment stating the following:

Is it possible that this is not an antagonistic move at all, from Greece's point of view? Could it be that far from kicking Greece, the ECB's real target is Germany? For some time now, it has been evident that Draghi is no fan of Germany's "Austerity Forever" stance. Pressuring Germany into negotiating might be his intention. But if so, it is a highly risky strategy. Pulling the waiver is likely to increase capital flight from Greece and raise Greek bond yields still further, putting further pressure on Greece's fragile finances. How exactly would this help Greece?

Alessandro Del Prete helpfully sent me this piece by Jacques Sapir which explains how weakening Greece's position could actually strengthen its hand (my emphasis):

In this strategic game, it is clear that Greece has deliberately chosen the strategy qualified by Thomas Schelling, one of the founders of game theory, but also of nuclear dissuasion, as « coercive deficiency »[5]. In fact, this term of « coercive deficiency » was imagined by L. Wilmerding in 1943 in order to describe a situation where agencies enter into expenses without prior financing, knowing that morally the government will not be able to refuse funding them [6]. Schelling’s contribution consists in showing that this situation can be generalized and that a situation of weakness can reveal itself to be an instrument of coercion upon others. He also showed how it can be rational for an actor knowing himself to be in a position of weakness from the start, to increase his weakness in order to use it in negotiation. Reversing Jack London, one can speak in this instance of a “strength of the weak.” [7]. It is in this context that we must understand the renunciation by the Greek government of the last slice of aid promised by the so-called « Troïka, » amounting to 7 billion euros. Of course, having rejected the legitimacy of said “Troïka, » it could not logically accept to take advantage of it. But, in a more subtle way, this gesture is putting Greece voluntarily at the edge of the abyss and demonstrates all at once its resolve to go the bitter end (like Cortez burning his ships before moving up to Mexico) and to increase the pressure on Germany. We are here in a full blown exercise of « coercive deficiency ».

This explains Varoufakis's "Do ahead" (he probably meant "Go ahead"). He stands at the edge of the cliff, and the ECB says "Do what we want or we will push you over". His response: "Go on then, push".

It must be remembered that this game is being played on a global stage. The US President, Barack Obama, has openly sided with the Greeks, warning that "You cannot keep on squeezing countries that are in the midst of a depression. At some point there has to be a growth strategy in order for them to pay off their debts and eliminate some of their deficits". And the UK's George Osborne, while calling for the Greek finance minister to "act responsibly", also criticised the Eurozone for its lack of a coherent plan for jobs and growth. Calling for the two sides to strike a deal, he warned that the standoff between Greece and the Eurozone is the "greatest risk facing the global economy". This seems like hyperbole to me, given the continuing crisis in Ukraine and military game-playing in the South China Sea, not to mention the Islamic insanity in the Middle East. But it all helps the Greek cause.

Varoufakis is gambling that the Eurozone, and more particularly Germany, will not dare to push him off the cliff because of the consequences for international political relations. If Germany was seen to force Greece out of the Euro by refusing to negotiate, it would become an international pariah. There are already voices reminding Germany of its own debt forgiveness in 1953, and anti-austerity movements in many other Eurozone countries would only be encouraged by Germany and/or the ECB looking like bullies. Forcing Greece out of the Euro could result in the disorderly unravelling of the whole thing.

I may be completely wrong, but this looks far more plausible to me than a simple explanation that fails to take account of the signals given by both Varoufakis and Draghi. In which case, Schäuble should beware.His position is nowhere near as strong as he thinks. He is dangerously close to the cliff edge himself. If Germany pushes Greece over the edge, Greece may well take Germany down with it.

The reality is that if Germany pushes Greece over the edge, it will be the beginning of the end of the eurozone as we know it. Why? Because it will send the wrong message to Spain, Italy, Portugal and even France, namely, that the eurozone is fine as long as Germany benefits and dictates fiscal and monetary policy.

This is the real issue, not Greece's debt which is being discussed ad nauseum in the financial media. Andreas Koutras told me flat out: "The debt restructuring is not the key. I have done a thorough financial analysis of the Greek debt. With small adjustments it is serviceable. Politicians concentrate on this because they want to avoid the real economy questions. It is easier to ask for haircuts than to grow your economy out of a hole."

While most in the market see Syriza as a threat to Greece's future in the euro zone -- and implicitly to their Greek and other European bond holdings -- the Providence, Rhode Island company praised voters for showing "tremendous courage."

Japonica says the previous government sold "fear" to its citizens by measuring what Greece owes in an inappropriate way."The public has been essentially lied to by the prior government about the debt," Japonica's finance director Christopher Magarian told Reuters by email.

"We are long-term holders and will work as hard as it takes to see justice for Greece."

After debt yields touched some of the highest levels since Greece's default in 2012 , Japonica says it is still comfortable with its bet against the market consensus.

It put out a tender to buy up to 2.9 billion euros ($3.3 billion) of debt in June 2013, raising its target to 4 billion euros the following month.

After checks in the Thomson Reuters eMAXX fixed-income search engine and conversations with former and current investors and brokers in Greek debt, Reuters was unable to determine the scale of Japonica's holdings of Greek bonds.

Given the tender was held privately, there is little trace of Japonica's involvement in the market. Some traders and investors see its public campaign as evidence it must hold some bonds.

Mr Varoufakis was coy about his talks with George Osborne on Monday, except to say that the Chancellor appeared to be on the “same page” on elements of Greece’s new debt plan.

The proposals offer a bond swap to ease the debt burden – 177pc of GDP - without demanding an explicit writedown of Greece’s foreign loans. This allows both sides to save face. The aim is to slash Greece’s primary budget surplus from the troika target of 4.5pc of GDP to around 1.5pc to pay for welfare pledges and boost investment. “This gives us a reasonable buffer. The old target is ludicrous,” Mr Varoufakis said.

Loans from the EU bailout machinery would be replaced by GDP-linked bonds, akin to Keynes’s "Bisque Bonds" in the 1930s. Money owed to the ECB would convert into “perpetual bonds”. “Everybody knows we are insolvent. What is the point of us borrowing another €7bn to pay back the ECB - which bought the bonds from north European banks to help them, not Greece – when the ECB is in the process of creating €1 trillion of new money? It is clearly absurd.”

“So why don’t we just park the bonds on the books of the ECB. What I am not going to do is borrow yet more money from my colleagues in Italy, France or Slovakia, or wherever,” he said.

Germany is convinced that EMU strategy is starting to bear fruit at long last - a view dismissed as wishful thinking by many economists around the world - and that concessions to Greece will set off a clamour for similar treatment from others, leading to a breakdown of discipline across southern Europe.Yet Syriza does not view Germany as an implacable opponent. Chancellor Angela Merkel has shown herself to be the ultimate defender of Europe’s post-war order and unity, all too aware of her country’s special duty of care. Other creditor states in the North have less compunction, while conservative leaders in Spain and Portugal reportedly wish to see Syriza crushed in order to fight off anti-austerity populists in their own countries.

Mr Varoufakis was an economics lecturer before being catapulted into the limelight as crusader against the “monumental folly” of Europe's deflation policies. An orthodox Keynesian – unlike neo-Marxists in the Left Platform of Syriza's broad church – he has taught at the universities of Essex, Glasgow, Cambridge, Sydney and Texas.

His latest works are “Europe after the Minotaur” and a “Modest Proposal”, a play on Swift. They are acclaimed blueprints for an EMU-wide reflation drive and a lasting peace to end Europe’s debt wars. They propose a mechanism to recycle the capital surpluses from the creditor states to the deficit states in a stable fashion to prevent the EMU economy as a whole becoming trapped in a self-feeding cycle of contraction. The arguments would be recognisable instantly to Keynes, who grappled with the same issues in the inter-war years when the Gold Standard went awry.

Mr Varoufakis is a fan of "game theory", a branch of economics epitomised by the Nash Equilibrium - the optimal outcome when each side knows what the other wants. But the current stand-off over Greece defies even the intricate formulae of Nobel theorist John Nash.

“Game theory only works if the players are rational. I am not sure that is the case in Europe. Even Nash would be at a loss here,” he said.

Indeed, game theory presupposes all players are rational, which is most definitely not the case here. Greeks leaders have hitherto put off much needed drastic cuts in the size of their grossly bloated public sector and German leaders refuse to admit that austerity in Greece and elsewhere has been a dismal failure which will only exacerbate global deflation (that is what really worries U.S. and Chinese policymakers).

Below, Greek Finance Minister Yanis Varoufakis met with his German counterpart Wolfgang Schäuble to continue talks on Greece’s debt in Berlin on Thursday. RT provides the press conference below. Take the time to listen to their comments (fast forward to their statements).

Also, take the time to watch this Bloomberg clip where professor and Nobel laureate Joseph Stiglitz discusses why austerity policies in
Europe have been a "dismal failure" and that a new approach is needed
including a form of fiscal union.
He speaks from Lindau, Germany, with Jonathan Ferro on Bloomberg
Television's "The Pulse."

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